Canada's Housing Bubble

Apr 01, 2010 Jonathan Tonge americacanada.blogspot.com

The Bank of Canada reported that the growth in outstanding NHA mortgage-backed securities (MBS) slowed in January. February marked the first month that the MBS balance decreased since August of 2008.

Bank of Canada: Residential and Household Credit

Canada's Economic Action Plan's $125 billion Insured Mortgage Purchase Program finally came to an end yesterday. The program eliminated the risk to banks, encouraging them to extend credit. In the event of a credit shock the banks could strengthen their balance sheets by offloading insured mortgages onto taxpayers.

No surprise then that the Teranet-National Bank National Composite House Index reported that January home price inflation was at its slowest pace since values started to recover early last year.

Furthermore, the Royal Bank of Canada announced that despite record low interest rates, home affordability was eroding. After a similar announcement in early 2008 the banks responded by removing the discounts on mortgages.

The banks raised fixed rates this week in response to the added risk. The Royal Bank of Canada led the pack by raising the advertised rate on the 5 year term by 0.6%. Other banks soon followed. Note that with Flaherty's new mortgage rules that these changes will make it more difficult to qualify for a variable rate mortgage as well.

This at a time when the Conference Board of Canada announced that over 20% of Canadians are struggling to afford their homes. RBC reported that 65% of Canadians are losing sleep over their finances:

....According to the March RBC Canadian Consumer Outlook Index, most Canadians (65 per cent) are losing sleep over their finances. More than one-in-four Canadians (27 per cent) are up at night worrying about paying off their debt, followed by nearly one-in-five (18 per cent) who worry about having enough for retirement and 16 per cent who worry about having no emergency fund...

As noted in the Country of Fiscal Prudence, the Canadian financial literacy task force will be looking into the following:

• With the Bank of Canada's interest rate set at 0.25%, how is it that 1/3 of Canadians are struggling financially? What happens when interest rates double, and the cost of debt does as well?
• Studies suggest that Canadians are wildly overly optimistic about their financial picture.
• Why Canadians feel that they'll retire comfortably but can't verbalize or explain how that will happen...

So while only 18% of Canadians worry about funding retirement, studies suggest that a decent portion of those not worrying should be.

CIBC reported in the Globe and Mail that Debt Will Bite Consumer Spending

The debt-to-income ratio, as a result, hit a record 147 per cent in December, and is accelerating at the fastest rate since the mid 1990s, Mr. Tal said.

Household debt is also climbing faster than assets, he added.

Some measures are improving – the savings rate is climbing and personal bankruptcies, though historically high, are slowing.

But by his combined measure, Canadian consumer fundamentals are at their weakest level in almost 15 years.

“The practical implication of the reduced consumer capability as measured by our index is that consumer spending will disappoint in the coming twelve months,” he noted in the report entitled “Canadian consumers – more confident but less capable.”

As interest rates are poised to rise this summer, and that will have a heavy impact on shoppers, he added.

“Given the vulnerable starting point of the consumer, the Bank of Canada will soon find that even a moderate monetary squeeze will be sufficient to drive a material deceleration in consumer spending.”

It's worth repeating:."Given the vulnerable starting point of the consumer, the Bank of Canada will soon find that even a moderate monetary squeeze will be sufficient to drive a material deceleration in consumer spending"

We should expect to see a rate increase as early as June 2010. While it will be mild, expectations for further rate increases will impact mortgage rates.

The time is near. We will soon approach a point where the expansion of household credit begins to slow or even contracts. I don't need to repeat how this will go down, but rest assured the supply of homes will rapidly increase and demand will fall. Lenders will react. Prices will follow suit.